Morning Report: Election Year Protection

(Stocks in this article: NYSE: SPY, NYSE: DIA, Nasdaq: QQQQ, NYSE: SDS, NYSE: GM, Nasdaq: MSFT, NYSE: BSC, NYSE: KBH, NYSE: SVU, Nasdaq: SBUX, NYSE: AVP, Nasdaq: LWSN, Nasdaq: INTC, NYSE: STZ)

The Fed's got your back! We have been catching a lot of feedback from institutional readers saying we are trying to catch a falling knife, recession is coming and the broader market has yet to adjust to the economic reality seen in housing and lending. Wall Street Greek agrees on all these points, and it does trouble us that the market has been late to coming to realization of recession. However, that does not mean it will not benefit in the short-term from a now very interested Federal government.

What does it mean to be in an election year? Why do markets generally rise during those periods? The reason is because each party wants to be seen by voters as working toward economic health. The most important topic according to the polls is the economy. So, you have both Republicans and Democrats aggressively acting, not just talking, to insure the economy does not tank. This is a great thing for investors, but it's a shame its mainly an election year phenomenon.

Just days after Fed-man Kohn said the government strongmen were trying to signal to the market future action, the Fed's Philly enforcer, Plosser, today said the Fed will act if things deteriorate. However, he also noted current expectations for a few sluggish quarters and rising concern about inflation. Last week, Kohn answered our protests here by saying that the Fed does not coordinate its representative's discussions. Clearly, this is a fault of its leaders both current and past. The Fed should in fact coordinate these discussions and all speeches should be reviewed before they reach and potentially confuse the market. Remember, before the last meeting there were contrasting views on the economy that made it seem the Fed was unsure; also it was unclear how the group was thinking with Kroszner and Bernanke saying different things than Kohn. Uncertainty is the worst enemy of the market. This is why I criticize Bernanke's leadership.

Hank Paulson showed that the administration, as well as the Republican party is hell-bent on addressing the economy in a proactive manner, or at least looking that way. Today he appeared on CNBC and discussed the administration's plans regarding a potential stimulus package. Do you see where we are going here? The administration is not going to sit back and watch the economy tank in an election year. They will likely go too far and err on that side of the table, rather than lose the Oval Office.

The Democrats are not going to sit back and relax either. You should notice sitting Senators Obama and Clinton grow increasingly aggressive about offering economic solutions, besides just offering criticism of the administration. Also, the Democratic Congress should come back into the forefront a bit and become vocal, projecting itself as a force for change and improvement.

All this offers a sort of insurance policy, election year protection. There will be some stimuli to help the economy and market to enjoy a rally sometime soon, however short-lived it could prove; the length of rally will depend on how bad the economy gets and how resilient it is to politically inspired mitigation. The Greek believes the Fed will act more aggressively this time around as well, even perhaps acting in concert with the administration. We're looking for a Fed target rate cut of 50-100 points at the end of January. Mishkin continues to hold his ace in his back pocket. Don't forget his white paper on the value of short and deep rate cut effectiveness. He is itching to put this into action folks, and he might have his chance right now. Any large cut like that would be a short lasting one though, but we will not worry about that until the time comes.

Imagine what happens to the financial sector and mortgage refinancing when this happens. Mortgage rates will drop also I suspect, because the reaction of the market could be mixed with panic. Pundits will worry that maybe this means things are worse than expected. Mortgage rates will get down low enough to save a bunch of borrowers, and get them out of those damned ARMS.

This is what the Fed should do in our view. Its cautious nature will probably limit it to a 50 point move, but that Mishkin is just itching, so don't rule out the big one. The market is not thinking about this; it's more concerned that the Fed will let us down again with a 25 point tweak. The January effect would be rolling along now if not for recessionary concerns, and this is why I suspect the surprise catalyst of government help will be the factor to move the market by the end of January. The only fly in the ointment is earnings season. The Q4 kitchen sink write-offs continue, and forward guidance is going to be ugly as well. This is a serious obstacle to equity rise over the near and long-term.

Analysts are still looking for a big rise in earnings in '08, plain and simply, because they are negligent. Too many analysts are waiting until they update Q4 numbers before making adjustment to '08 in earnest. There is no other explanation for this then negligence. You see, a lot of these guys at the independent operations that try to provide everything to everyone (figure out who I'm talking about) don't make half as much as the I-bank analysts do, and they have no incentive to stay late and work up their estimates for you. In fact, they are told their jobs are 9-5 gigs. I KNOW FROM EXPERIENCE.

The handful of guys that stick around after five o'clock to do things right at these firms, do it out of their own sense of fiduciary responsibility, their own moral values and ethical concerns; but the fact is they are not recognized for it. I worked my tail off doing things right as a sell-side analyst following 30-40 companies (with no assistant), and I watched a short cut taker who had not one earnings model on his 40 major banks rise to Director of Research. Why? Because while I toiled doing things right, he had free time to do "extras." In fact, this SOB took my DCF model, canned it into something the entire research department could use, and was promoted to the top. It didn't hurt that he rode the boat home with his boss every night either.

Take it from me, doing things right never paid off financially, but I can sleep at night knowing my soul is not sold to the devil. My resentment is consoled also, knowing that his soul is doomed. I'm also not the kind of guy to sit back and take crap like that, so I told him about it. I also told his superior when she came into her new CEO position and asked for an "anonymous" survey. Shortly after that survey, I also noticed a suddenly increasing and mysterious pressure on me from above alongside a hostile environment. And this SOB even uttered under his voice one day how he would finish me, so I knew it was time to get out. But, I'm not finished yet... The good guys always win, and we write books sometimes too.

Anyway, these broad estimates are skewed by the in-house estimates of the shop I described. So, when you wonder why the numbers always seem behind the curve, that's the simple explanation that nobody else could inform the market about but me. People just assume that analysts generally are behind the curve. That's not the case. It's a group of underpaid, poorly managed analysts who drive these numbers. Keep in mind, it's not the individual analysts' fault; they have a choice to make, personal sacrifice or excel in the system they exist within. Most people would choose to adjust to the system. It takes a special kind of person to seek to do better at personal cost. Those people exist as well, and many of them are my friends.

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